James Hyerczyk
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The free ride to multi-year highs by the Australian and New Zealand Dollars came to a screeching halt last week as the U.S. Dollar surged on the back of an increase in U.S. bond yields.

Global bonds, and particularly U.S. Treasuries, became the focal point of markets globally last week. Meanwhile, traders moved aggressively to price in earlier monetary tightening than the Federal Reserve, Reserve Bank of Australia and Reserve Bank of New Zealand have signaled.

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Last week, the AUD/USD settled at .7704, down 0.0165 or -2.10% and the NZD/USD finished at .7233, down 0.0064 or -0.88%.

The benchmark 10-year Treasury yield surged above 1.6% for the first time in a year. With that news, The Australian Dollar started to retreat from its first high over .8000 since February 2018. While the New Zealand reached .7465 then plummeted the next two sessions.

The Aussie fell sharply despite the market signaling expectations of higher economic growth. It was pressured because the country’s central bank’s yield curve control policy would restrain its bond yields moving much higher. That, in turn, could limit the attractiveness of the currency going forward.

Short-Term Outlook

The steep drop in the Australian Dollar was accompanied by a plunge in Australian Government bonds, which caused the Reserve Bank to hit the panic button. The RBA waded in with more than US$2 billion of unscheduled purchases.

While the response by RBA policymakers appeared to calm bond investors, it’s unlikely to bridge a deepening divide between traders and central banks over the pace of the economic recovery. Policymakers fear the so-called reflation trade, already rippling through all markets, could seep into economies that have yet to rebound from the coronavirus shock.

“Reflation now needs a rein, and central banks are fighting the sharp rise in yields,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore. “Their credibility is at stake here too – if they want to maintain accommodative policy they have to act if markets look like they’re running away.

The RBA is taking the lead in acting as a breakwater for rising yields, a role typically played by the Bank of Japan. Its offer to buy A$3 billion ($3.1 billion) of debt acted to brake the sell-off, with Australia’s three-year bond yield erasing gains.

There are expectations that global central banks will try to contain a further rise in yields, said Kei Yamazaki, a senior fund manager in Tokyo at Sumitomo Mitsui DA Asset Management. He added:  “Fed officials have been tolerating the recent rise in yields, but the current risk-averse market will also prompt them to calm the market verbally,” Bloomberg reported.

For a look at all of today’s economic events, check out our economic calendar.

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